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Can't Pay Your Taxes?

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By Roy Lewis
August 3, 2001

Let's face it -- sometimes bad things happen to good people. And this is the case when you find that you owe the IRS a bunch of money, and may not have the ability (or assets) to make the payments in full. It's also possible that the liability is quite old, and the interest and penalty assessments have ballooned the balance to an untenable amount. What can you do now? You want to get on with your life and move forward, but you have this dark cloud hovering above you.

It seems like an impossible situation, but it doesn't necessarily have to be. You may have heard somebody tell you that they can get the IRS to "settle" the matter for 20 or 30 cents on the dollar. What these people are talking about is preparing an "Offer in Compromise" (OIC) to present to the IRS.

In the most simple of terms, an Offer in Compromise is a request that you make to the IRS that says that you simply don't have the resources to make the payment in full. And, surprisingly enough, the IRS might just allow you to pay less than the full amount of the total liability in order to get at least some payment and promote more effective tax administration.

As a policy matter, the IRS is favorably inclined to settle a delinquent account when it is not collectible in full and criminal proceedings are not pending or contemplated. Translating this policy into practice, however, is not always easy. Frivolous offers or offers submitted for the purpose of delaying the collection of tax liabilities will be immediately rejected. If an Offer in Compromise is withdrawn or rejected, any amount tendered with the offer is refunded without interest unless you wish to have the amount applied to the liability that was the subject of the offer.

Grounds for compromise
After the IRS has assessed the tax liability, the amount can be compromised on any of the following three grounds:

1. Doubt as to liability: There may be a genuine dispute as to the existence or amount of the correct tax liability, but no adjustment can be made on the basis of doubt as to liability if the tax liability has been conclusively determined by a closing agreement, a final Tax Court decision, or other judicial determination. Doubt as to liability means more than a mere suspicion of doubt or a mere possibility of a different result; your contentions should be supported by tangible evidence and you should provide a thorough explanation of the basis for asserting that liability is doubtful. This is a difficult standard to meet, but should not be overlooked.

2. Doubt as to collectibility: Doubt as to collectibility exists in any case where your assets and income are less than the full amount of the assessed liability. Such a determination must consider your ability to pay, and in determining the ability to pay, you must be permitted to retain sufficient funds to pay basic living expenses. The IRS has published schedules of national and local living expense standards to help in evaluating such needs. The IRS will look at the specific facts and circumstances of each case in making their determination. There is a bunch of paperwork, forms, and schedules that will be required if you decide to use this standard for your offer, but the standard is much less stringent than the "doubt as to liability" requirements.

3. To promote effective tax administration: If neither of the grounds of doubt as to liability or doubt as to collectibility exists, a compromise may nevertheless be entered into to promote effective tax administration. This can happen when collection of the full liability will create economic hardship, or, regardless of your financial circumstances, there may be such exceptional circumstances that collection of the full liability would be detrimental to voluntary compliance by taxpayers. In either case, however, such a compromise will not be accepted if it would undermine compliance by taxpayers with the tax laws. Your record of overall compliance with the tax laws weighs heavily in such a consideration.

Procedures and forms
If you think that an Offer in Compromise might be in your future, then you'll want to submit the offer using IRS Form 656, paying particular attention to the instructions for Form 656. Additionally, if you're contemplating submitting the offer on a "do-it-yourself" basis, you'll also want to carefully read the applicable sections of IRS Publication 594. You'll also want to review IRS Publication 1854 to help you in preparing the appropriate collection statements.

Once you submit your offer, don't expect a response the very next week. There are many offers under review at any time, so you'll have to wait your turn for IRS personnel to get to yours. IRS specialists dealing with Offers in Compromise are literally buried in paper, so don't be too impatient.

The IRS's position is to be carefully neutral when discussing an Offer in Compromise. The IRS cautions its employees against suggesting terms, suggesting that you submit an offer, or suggesting that discussion of an offer constitutes acceptance. This is one of the reasons that you might want to engage the services of a qualified tax pro in helping you prepare and negotiate the offer. You can't expect the folks at the IRS to give you "tips and hints" to prepare your offer. But, at the end of the day, if the collection officer concludes that a compromise would be in the government's interest, the officer is expected to explain compromise procedures and inform you of your right to make an offer.

If the IRS rejects your offer, you must be given prompt written notice of the rejection. You can then request a meeting with the office having jurisdiction to discuss an acceptable compromise. If agreement is not reached during this meeting, you can protest to the Appeals Office.

Word of warning
There are a number of organizations out there that will virtually promise you that they can get your taxes reduced by filing an Offer in Compromise for you. How do they find you? Tax liens are public record, so they can easily determine that you have tax problems simply from those records. You might receive a call or letter from them. In some cases, these firms and organizations will advertise in the local paper.

They'll generally want their fees paid upfront, and the fees are usually not refundable if the offer is declined by the IRS. Remember that in order for the offer to be accepted, it needs some basis in fact. The IRS generally won't take less than the full amount of the tax liability "just because."

Heck, if you weren't in financial trouble already, you wouldn't need to make an Offer in Compromise. So before you send hard-earned money to such a firm or organization, take a close look at the rules and regulations and see if you have any reasonable basis to qualify for an Offer in Compromise.

There are many reputable tax pros out there who will be happy to meet with you and discuss the merits of your case and the possible outcome prior to charging you big fees. Those are the folks that you'll want to retain to represent you in dealing with the IRS and in preparing your Offer in Compromise.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.

This forum and the information provided here should not be relied on as a substitute for independent research to original sources of authority. The Motley Fool does not render legal, accounting, tax, or other professional advice. If legal, tax, or other expert assistance is required, the services of a competent professional should be sought. In other words, if you get audited, don't blame us.